The Financial Crimes Enforcement Network in the Treasury Department (FinCEN) recently released proposed forms implementing the beneficial ownership reporting requirement of the Corporate Transparency Act (CTA) that would undermine the purposes of the new law. To combat money laundering, terrorist financing, tax evasion, and other financial crimes, the CTA requires certain entities to report information about their beneficial owners, thereby creating an important database for tax administration and other law enforcement. But, by allowing those with reporting obligations to mark virtually all of the relevant information required by the statute as “unknown,” FinCEN’s proposed forms would render this database almost worthless.
The proposed forms are inconsistent with the statutory framework, inconsistent with the way similar information-reporting regimes are implemented, and bring into question whether the Biden administration’s implementation of the CTA will, as Treasury Secretary Janet Yellen suggested in September, in fact, “level the playing field for honest businesses that play by the rules but are at a disadvantage . . . competing against bad actors who use shell companies to evade taxes, hide their illicit wealth, and defraud customers and employees.” This proposed watered-down approach to implementing the CTA would also leave the United States unable to meet international financial integrity and anti-corruption standards. The administration should make significant changes to these forms before finalizing them, including removing the option to respond “unknown” to the majority of the fields.
Proposed Forms Hollow Out the CTA
The CTA calls for “reporting companies” (certain corporations, limited liability companies, and other entities) to fill out forms called information reports. The statute requires these reports to include specific information about the individuals who are the reporting companies’ beneficial owners: full names, addresses, and identifying documentation. Establishing a functioning and complete beneficial ownership database is an important tool for combating money laundering, tax evasion, and other financial crimes. The CTA’s anti-corruption goal is especially critical in the wake of the Panama Papers and Russian sanctions, both of which have drawn attention to the United States’ status as a haven for illicit finance.
Assets and income associated with financial crimes are currently often hidden from regulators, including the Internal Revenue Service (IRS), using chains of entities to obscure who actually owns the assets. Incorrectly reported income from opaque entities like partnerships are among the largest sources of revenue shortfalls that comprise the tax gap (taxes owed but not paid). Tax evasion is often highly intertwined with other financial crimes, as noted by the OECD. The beneficial ownership database is intended to make it harder for unscrupulous actors to hide their assets in this way. As we have previously written about, the IRS’s access to accurate beneficial ownership information for tax administration, sanctions enforcement, and criminal investigation purposes is also critical for ensuring that the CTA meets its goals – a purpose affirmed by FinCEN’s second proposed rulemaking that confirms separate ongoing access to the beneficial ownership database for the IRS.
Now, however, FinCEN has proposed allowing reporting companies to respond “unknown” to virtually every field that the statute requires. Moreover, the proposed form has virtually no instructions on the type of due diligence reporting companies must undertake to obtain the statutorily required information before answering “unknown.” The ability to answer “unknown” to required fields would encourage unscrupulous reporting companies to sidestep the entire reporting regime at the heart of the CTA.
Proposed Forms Are Unlikely to Meet International Standards
In addition to undermining the CTA’s purposes domestically, these proposed forms will make it difficult or impossible for the United States to fulfill its international reporting obligations to partners and allies. Even before the proposed forms were released, the CTA was already subject to criticism by the EU for not including beneficial ownership reporting for all entities. FinCEN’s move to weaken the reporting regime is also surprising given that after the finalization of the first round of rules last year, Yellen specifically emphasized the CTA would help the United States maintain such obligations by “more effectively combat[ing] financial crime alongside our partners and allies under strong global standards.” As noted in my previous article for Just Security, commentators have argued that financial transparency can reduce the global instability that is often exacerbated by hidden financial dealings while simultaneously countering authoritarianism, which often thrives due to corrupt practices.
Furthermore, as a member of the Financial Action Task Force (FATF), a G7 group that sets standards for members regarding money laundering and terrorism financing policies, the United States was party to adopting more stringent beneficial ownership standards last year – including setting up reliable beneficial ownership registries accessible to regulators. Yellen commended these new standards last March, stating that the FATF’s focus on strengthening beneficial ownership standards would “aid all countries in identifying criminals and their funds hiding behind corporate structures. By strengthening financial integrity, we can better protect the global financial system from corrupt officials hiding their stolen wealth and undermining transparency, accountability, and democracy. This is a priority of the United States at home and abroad.”
FinCEN’s Justification Unclear
There is no apparent statutory basis for FinCEN’s decision to propose “unknown” as an option for reporting beneficial owners’ information. Indeed, it runs counter to the CTA’s requirement that Treasury promulgate regulations that “ensure the beneficial ownership information reported to FinCEN is accurate, complete, and highly useful.” Forms that allow reporting companies to simply say they don’t know who their owners are or don’t have the other required information, would obviously not be “highly useful” for law enforcement agencies relying on the CTA database to understand who ultimately owns illicit assets.
A key purpose of the CTA is to provide information that is highly useful for tax administration, yet the proposed approach is inconsistent with the usual approach to collecting tax information. In other information-reporting regimes for tax purposes, there is usually an immediate consequence for not fully reporting the required information, for example as a higher withholding rate on a Form 1042-S (the form for withholding on a foreign person’s U.S.-source income). Even if FinCEN treats an “unknown” response on the beneficial ownership information report similar to forms where the inability to identify information serves as a potential flag (such as a financial institution’s Suspicious Activity Report), the number of “unknown” responses will either overwhelm FinCEN’s limited resources or – more likely – render the forms useless for enforcement activity.
Given that the statutory framework provides little support for this proposed approach to the forms, it is unsurprising that FinCEN does not explain the statutory authority it is relying on for this proposal. Nor does FinCEN explain what it considers to be an appropriate level of due diligence for reporting companies to undertake before they tick “unknown.” This lack of instruction means the most unscrupulous actors – those that the CTA regime needs to shed light on the most – may try to avoid understanding their ultimate owners or make only superficial attempts to do so to keep ticking “unknown.”
The statute itself provides that those willfully failing to report or providing incomplete information will be subject to penalties up to a maximum $10,000 fine or two years in prison. However, neither the proposed form nor FinCEN’s other guidance provides any information about when FinCEN will apply these penalties. This invites dishonest actors to liberally use the “unknown” checkboxes on the forms to test the boundaries of the “willful failure” standard (which is often high), while also creating uncertainty for honest actors about the level of due diligence needed to check “unknown.”
Administration Should Eliminate the “Unknown” Response Option
The CTA should be understood by its very nature as requiring business entities to engage in diligence and gather information that they may or may not currently have about their beneficial owners. Congress did not write in an exception for presently unknown information and the reason is clear: doing so would have undermined the very purposes of the law. In addition to failing to ask business entities to affirmatively gather information, the proposed “unknown” box on the form risks encouraging those responsible for filling out the form to report that information they do know is “unknown” without the government easily being able to show otherwise. Depending on how the statutory reporting violation penalty is interpreted, it may even be possible that such individuals could try to keep themselves ignorant to avoid having knowledge that would be required to be reported.
There is no statutory basis for the “unknown” option and allowing an this response undermines the entire beneficial reporting regime, particularly as it pertains to identifying information for beneficial owners. Even if this information is ultimately unavailable despite concerted due diligence, removing “unknown” as a response option will encourage more substantive compliance efforts.
If FinCEN nevertheless wishes to allow respondents to respond with an incomplete form, it should explain why it believes it has the authority to do so given that it undercuts the statutory purpose and seems inconsistent with the statutory framework. Rather than including “unknown” and “unable to identify” fields, FinCEN should instead provide an additional field for respondents to explain why any part of the form is incomplete and explain their due diligence undertaken to obtain the information. And it can look to numerous examples of European countries instituting their own beneficial ownership regimes for examples of the types of stringent due diligence that should be required in any such regime. For example, Malta instructs that if the company has “exhausted all possible means” and is still unable to identify beneficial ownership information, that the company keep records as to the actions taken in order to identify the beneficial ownership. Ireland requires that “all reasonable steps” be undertaken to identify beneficial owners, defined as giving notice to the person that the entity has reasonable cause to believe is the beneficial owner or any person they reasonably believe to have knowledge of information regarding the beneficial owner, allowing each person one month to respond. While these are different statutory frameworks – and again the CTA itself does not seem to support any “unknown option” – they are indicative of the need to ensure that reporting companies adhere to a high standard of due diligence for beneficial reporting regimes to meet their shared anti-corruption purposes.
The NYU Tax Law Center, where I work, previously wrote about the statutory holes in the CTA after the first set of implementing rules issued by FinCEN were finalized, but FinCEN’s latest proposed information-reporting form would now turn what remains of the CTA into an optional reporting process. This is unacceptable for a regime that is intended to provide useful information on the most opaque and unscrupulous use of entities to hide assets from law enforcement agencies, including the IRS. FinCEN should remove the “unknown” response option in the information report form to ensure that the reports contain beneficial ownership information that is accurate, complete, and highly useful — or risk imposing a reporting burden with no discernable benefit to tax administrators or law enforcement.